retirement planning | december 11, 2023
How Laws Governing Inherited IRAs May Mean Changes to Your Plan and RMD Rules for Your Beneficiaries
The original SECURE Act changed distribution rules for Inherited IRAs, limiting the option to stretch withdrawals.
Key Insights
Recent rules for Inherited IRAs could have a significant impact on investors with sizable balances in their Traditional IRAs or 401(k)s.
There are different distribution provisions depending on the beneficiary’s relationship to the original owner.
It is important to understand the nature of the changes and how they might affect your own plan and situation.
Judith Ward, CFP®
Thought Leadership Director
The SECURE Act of 2019 created three categories that apply to beneficiaries of retirement accounts whose original owners die after 12/31/2019—eligible designated beneficiaries (EDBs), noneligible designated beneficiaries (NEDBs), and non-designated beneficiaries (NDBs)—and limited the option to stretch withdrawals from some Inherited individual retirement accounts (IRAs) over the lifetime of the beneficiary. Many non‑spousal beneficiaries are now subject to a 10-year rule, meaning they must withdraw the full balance of their Inherited IRA by the end of the 10th year following the death of the original account owner. This change could have a significant impact on the financial plans of investors with sizable balances in their Traditional IRAs or 401(k)s.
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What Happens When You Inherit an IRA?
An Inherited IRA is a separate type of legally registered individual retirement account that is established when a beneficiary inherits assets originating from a retirement account such as a 401(k) or IRA. It has its own unique set of rules and implications. In most cases with an IRA inherited from someone other than a spouse, the tax‑advantaged assets are simply moved from the deceased original owner’s account into the beneficiary’s Inherited IRA. Spouses have the option to move such assets into a newly established Inherited IRA or treat the assets as their own and move them directly into their own IRA.
However, the rules governing distributions from Inherited IRAs can lead to some complex planning. There are different distribution provisions depending on the beneficiary’s relationship to the original owner and whether the original owner had reached their required beginning date (RBD). The RBD is the date that required minimum distributions (RMDs) must start. It is currently set at April 1 of the year following the year in which the IRA owner reaches age 73 and is scheduled to change to 75 in 2033. Of course, beneficiaries can always withdraw more than the RMD, at any time.
The assets in an Inherited IRA carry over the tax treatment of the original account.
If the assets were originally held in a tax‑deferred account such as a Rollover or Traditional IRA, withdrawals from the Inherited IRA would generally be treated as taxable income to the beneficiary owner at ordinary income tax rates.
Similarly, assets originally held in a tax‑free account such as a Roth IRA will usually maintain their tax‑free withdrawal status when distributed from the Inherited Roth IRA by the new beneficial owner.
Understand Who Can Do What With an Inherited IRA And If They Need To Start Taking RMDs
Successfully incorporating an Inherited IRA into your financial plan begins with understanding how the payout options differ among the various beneficiary categories. (See the “Who Can Do What With Inherited IRA Assets” chart.)
Eligible Designated Beneficiaries
The individuals in this group have the most flexibility in how they choose to handle the IRA assets they inherit and can still choose to stretch RMD payments. The term stretch refers to a financial strategy that allows beneficiaries to extend the tax‑deferred benefits of IRA assets by recalculating their RMDs based on their own life expectancy rather than that of the original account owner. The most common beneficiary in this category is a spouse.
Spouses
With the most options of any beneficiary, spouses can do the following:
If the spouse is the sole primary beneficiary, they can move the IRA assets they’ve inherited into their own IRA and treat them as their own.
This strategy resets the clock on any RMDs and means the assets won’t need to be withdrawn until the surviving spouse’s RBD. Especially beneficial for surviving spouse younger than decedent.
If the deceased spouse had reached their RBD, their final RMD will need to be satisfied upon moving the assets to the surviving spouse’s own IRA.
Transfer the assets into an Inherited IRA with the option to begin taking withdrawals even if the surviving spouse is younger than age 59½.
There is no 10% early withdrawal penalty on distributions from an Inherited IRA.
RMDs would eventually start at the original owner’s RBD—or immediately if the original owner had already passed their RBD.
The RMDs would be based on the longer of the surviving spouse’s life expectancy or the age‑based life expectancy of the deceased original owner.
Note that a surviving spouse could initially title the account as an Inherited IRA and then roll over the assets into their own IRA later, but they cannot do the opposite.
The stretch IRA option was a popular planning technique for passing on tax‑deferred assets to heirs. With this change, some investors may have to reexamine their legacy planning. 
- Judith Ward, CFP®, Thought Leadership Director
Who Can Do What With Inherited IRA Assets
A look at beneficiary options if the original owner’s death occurred in 2020 or later.
1Once the surviving spouse elects to roll the assets as their own, it cannot be undone.
2Surviving spouse can have access to funds prior to age 59½ without early withdrawal penalty and with the ability to roll over assets to their own IRA at a later time.
3Persons older than or less than 10 years younger than decedent (e.g., siblings, friends, parents). Disabled or chronically ill persons as defined by IRS.
Reminder: If the original owner died on or after their RBD, their final RMD will need to be satisfied upon moving assets to heirs.
This information is based on proposed IRS regulations published in February 2022. It is possible they could be subject to change when the regulations are finalized at some point in the future.
Other Eligible Designated Beneficiaries
The eligible designated beneficiaries group includes minor children of the deceased, disabled persons, chronically ill persons, and beneficiaries who are older than or less than 10 years younger than the original owner (such as siblings, parents, or friends), among others.
Like spouses, they are not subject to the 10‑year rule, but they must transfer the assets into an Inherited IRA—they cannot move the assets into their own IRA.
Most beneficiaries in this group must begin taking RMDs in the year after the death of the original owner, but they can stretch those RMDs over their own life expectancy.
Beneficiaries who are minor children of the original owner have a slightly different set of options.
Until they reach age 21, they must take RMDs based on their life expectancy.
They then must follow the 10-year rule, essentially having to fully distribute the account in the year they turn age 31.
Noneligible Designated Beneficiaries
The group known as noneligible designated beneficiaries represents most non‑spouse beneficiaries who are more than 10 years younger than the original owner and aren’t minor children of the deceased account owner.
Individuals in this group must now withdraw the full balance of the Inherited IRA by the end of the 10th year following the death of the original owner. (See the “Potential Tax Impact for Inherited IRA 10-Year Drawdown” example.)
Annual withdrawals are only required if the original owner had already reached their RBD. In that case, the RMDs are based on the beneficiary’s single life expectancy, and the account still needs to be liquidated fully by the end of the 10th year following the original owner’s death.
Non‑designated Beneficiary
The third category, non‑designated beneficiary, pertains to an entity rather than a person. There may have been no beneficiary named on the account and, therefore, it is left as part of the decedent’s estate or as an entity such as a charity or nonqualified trust. In these situations, the account must be totally liquidated by the end of the fifth year following the decedent’s death, if the decedent had not reached their RBD. If the decedent had reached their RBD, RMDs are based on the decedent’s age in year of death.
Potential Tax Impact for Inherited IRA 10-Year Drawdown
Taking larger distributions over 10 years can help even out tax rate and reduce total income taxes owed. The following charts illustrate the tax impact for three respective Inherited IRA 10-year drawdown approaches. In all scenarios, the beneficiary has inherited $500,000 in pretax IRA assets as a non-designated beneficiary, has $125,000 in taxable income (salary minus deductions), and is therefore in the 24% single filer federal income tax bracket.
Scenario 1 applies to situations in which the original IRA owner had reached RBD prior to death and therefore RMDs (based on the beneficiary’s life expectancy) must begin the year after the owner’s death, until full liquidation in year 10. Only RMDs are taken until year 10. (See “Assumptions1.”)
Scenario 2 assumes no withdrawals until full liquidation in year 10 and applies to situations in which the original IRA owner had not yet reached RBD and therefore no RMDs are required.
Alternative could apply to any non-designated beneficiary. We are assuming $55,000 IRA distributions each year, to spread out taxes (but staying within the beneficiary’s current bracket), and then full liquidation of the remaining balance in year 10.
1Assumptions: The beneficiary is still working and has $125,000 in annual taxable income (salary minus deductions) and is therefore in the 24% single filer federal tax bracket. $500,000 IRA at time of inheritance is 100% pretax. 6% annual growth rate assumed for IRA. IRA distributions are taken at the beginning of each year, except at the end of year 10. Taxes are assumed to be paid at the end of each year and are based on federal rates at 1/1/2023. For illustrative purposes only: No wage increases, inflation adjustments to tax brackets or any investment income are reflected. For Scenario 1: We are assuming the beneficiary is 55 years old and their beginning RMD factor is 31.6, -1 for each year thereafter. Annual RMDs range from approximately $15,000 to $25,000 over that time. For Scenario 2: The IRA owner had not reached RBD age before date of death, and no annual distribution is required. Account must be liquidated by end of year 10.
The Importance of Planning Ahead
An inheritance of any amount is welcome, but these changes mean that IRAs with large balances can potentially trigger large tax liabilities for non‑spouse beneficiaries.
Given that many non‑spouse beneficiaries are adult children in their peak earning years, such a boost in taxable income may have significant tax consequences. Spouses have some flexibility to plan around how they receive their inherited funds, but adult children do not. It is therefore up to the original account owner to understand the implications of the change in laws and to consider adjusting their plans accordingly.
There are a few planning options for the original owner to consider:
Seek tax diversification in your contributions. Directing your retirement savings into a mix of accounts with different tax treatments, such as taxable accounts, Roth accounts, and tax‑deferred accounts, can help reduce the size of your tax‑deferred account balance and limit the tax consequences for your beneficiaries, particularly for any non‑spouse beneficiaries.
Consider executing Roth conversions. While the assets in an Inherited Roth IRA would be subject to the same withdrawal rules as assets inherited from any other type of tax‑deferred account, the eventual withdrawals are generally tax-free. Converting Traditional IRA assets to a Roth account would help your beneficiaries avoid a large tax liability from having to liquidate the Inherited Traditional IRA within 10 years. The conversion would trigger an immediate tax liability for the original owner, but they could ideally implement a staggered conversion strategy during lower income years.
Take withdrawals from your Traditional IRAs before you reach RMD age. By starting withdrawals earlier than you’re required, you can gradually reduce the balances in your tax‑deferred accounts while spreading out the ordinary income tax implications for your household over a longer time span. If those funds are not needed for income, consider reinvesting them in a taxable investment account. This way, heirs may benefit from a “step up” in cost basis upon the distribution of the estate. (Just be sure, as the original owner, to delay withdrawals until after age 59½ to avoid early withdrawal penalties.)
If you're age 70½ or older and charitably inclined, consider qualified charitable distributions (QCDs). You can distribute up to $100,000 per year from an IRA directly to a charitable organization, and that amount will not be considered taxable income. At RMD age, QCDs up to $100,000 will count toward your RMD that year and will not be subject to tax. Keep in mind, however, that any amount gifted over your RMD in a given tax year cannot be carried forward and counted toward your RMD in subsequent years.
While these funds would not be available for heirs, it may assist you in meeting your charitable goals while reducing Traditional IRA asset balances your beneficiaries might receive.
As with any change in the rules governing retirement accounts, it is important to understand the nature of the rule change and how it might affect your own plan and situation. If your situation seems complex, seeking a professional opinion or estate planning advice may be well worth the time. It would not only be a benefit for your peace of mind, but it would benefit your heirs as well.
These changes underscore the importance of naming beneficiaries to your retirement accounts and understanding how those assets will be distributed. - Judith Ward, CFP®, Thought Leadership Director
Important Information
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action. T. Rowe Price does not provide tax advice. Please consult your tax or financial professional regarding questions specific to your situation.
The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
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Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.
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